The break-even point is the point in time where total revenues and total expenses become equal, with no amount higher than the other. At this point, all costs have been paid, but there are no profits. For most businesses, breaking even consists of selling a certain amount of product each month. If over this amount, a profit has been achieved. If below this amount, a loss has been incurred.
Because of the close ties between expenses and revenues, increased revenues may mean that expenses must be raised to compensate for the higher sales and vice versa. These are referred to as variable expenses. On the other hand, fixed expenses are not dependent on sale and are incurred regardless. Mixed expenses contain elements of variable and fixed expenses. For example, there is typically a minimum amount which must be paid for utilities; this amount increases as usage increases.
Typically, it is best for a business to try to reduce fixed and variable costs and increase revenues. The contribution margin refers to what a business receives from sales after expenses have been paid. This margin can be further used to determine the amount of profit for an individual unit of product. This is determined by subtracting expenses per unit from revenues per unit. If a business wishes to earn a certain amount of profits based on units or sales rather than simply breaking even, the contribution margin can also be used after some adjustments. In order to meet the desired profit, fixed expenses should be raised to compensate.
The contribution margin ratio is used for determining the break-even point in terms of dollars, as opposed to units sold. This ratio is factored by dividing total sales, minus all variable expenses (also known as the contribution margin), by sales. Note that the contribution margin ratio can be used to determine total sales or revenues per unit.